Better pricing, utilisation to keep KPIT code firm

KPIT Cummins, a specialised IT solutions provider, is expected to gain from rising discretionary spending by manufacturing and business corporates globally.

Business
KPIT Cummins Infosystems, incorporated in 1990, has largely followed an inorganic growth strategy over the years, having made eight acquisitions since 2002. The company currently operates through four strategic business units (SBUs) — automotive and engineering, integrated enterprise solutions, SAP and semiconductor solutions.  Automotive and engineering is the company’s niche segment and contributes almost 27% to consolidated revenues. Integrated enterprise solutions, which contributes 38% to topline, caters to business IT offerings such as supply chain management, Oracle transportation management, business intelligence, manufacturing execution systems, e-biz solutions, enterprise software support and consulting. The SAP SBU, which contributes 32% to overall revenues, caters primarily to the SAP ERP along with related business intelligence and e-biz solutions. the semiconductor solutions SBU provides engineering services in chip design and verification and generates 3% of the overall revenues.

KPIT, which caters to three major industry verticals — automotive, transportation & manufacturing, energy & utilities, and defence & government — derives almost 68% of its revenues from the US and 20% from Europe. It has almost 155 active customers with 40 giving more than $1 million per year revenues repeatedly. It gets close to 52% from its top 10 clients with Cummins alone contributing 23% to topline numbers.

KPIT Cummins has entered into a joint venture with Bharat Forge to manufacture a plug-in parallel hybrid solution, Revolo, for cars, which would reduce the harmful gas emissions and increase fuel efficiency. The company expects the product to start contributing to revenues by fiscal 2013 to the tune of Rs300-500 crore.

Investment rationale:
The company derives maximum revenues from overseas and has been witnessing strong growth at its subsidiaries, led by improving confidence among automotive and manufacturing clients in the US and Europe, which is leading to higher budget allocations. It is increasing focus on China, Korea and India, where growth is much higher. 
It is estimated that auto electronics would constitute 40% of the total components cost in the next 3-4 years, which would benefit embedded software and product engineering companies.
KPIT sees huge opportunity in outsourcing in engineering services related to defence and aerospace sector and has started working with Indian defence segment for auto embedded offerings like vision systems, hybrids and navigation systems.

The company has also been able to increase its billing rates consistently over the last year-and-a-half and expects 3-5% rate increase this year. Also, it has recruited a lot of freshers in FY11, which is likely to help ease the wage pressure. It is also looking to increase its offshore and fixed price project revenues, which offer better margins, apart from improving utilisation rates further.

Revolo, for which road tests of pilot vehicles and consumer trials are currently on, is likely to start contributing to the company’s revenues and profitability by fiscal 2013. Any positive update on this front would be an additional trigger for the stock.

Concerns:
The company faces risks related to foreign exchange fluctuations, attrition and slowdown in engineering spend in developed countries. Its substantially high exposure to automotive with less focus on BFSI segment also presents risk. The company may see operating margin pressure due to wage hikes and more investments into research and development in the near term.

Valuations:
Driven by higher utilisation rates, increase in pricing and higher volumes; the company’s revenue are expected to grow at a CAGR of over 21% over FY11-FY13E, while the net profits are likely to grow at a CAGR of 19% over the same period. At the current market price of Rs163.65, the stock trades at 13.04 times its expected FY12 earnings and at 10.7 times its FY13 earnings per share. One can enter the stock on declines from a medium-to-long-term perspective.

Disclaimer: The writer does not hold any share in the company.